Chapter 4. What makes up the FICO Score?

 

All financial institutions that lend funds to consumers owe an obligation of reporting the financial behavior of their consumers to the three reporting agencies (Experian Links to an external site., Transunion Links to an external site., Equifax Links to an external site.). These three credit reporting agencies, also known as credit bureaus, collect financial information and keep track of the financial behavior of consumers from lenders and other vendors. Through this process, each consumer establishes a credit history that gets recorded in a report.

 

Based on that, each of the credit bureaus issues a three-digit financial grade, known as a credit score or FICO Score (Fair Isaac Corporation). In order for you to protect your financial reputation, you need to monitor your financial behaviors and understand the interrelationships among the use of your credit card, history, report, and score. Start with asking yourself some of the questions below: 

 

How to

In order to answer these very important questions, you need to fully understand what makes the FICO score, what is the weight or influence of each element on the overall score, and what is in a credit report.

What makes up the score?

*Image from MyFico.com

What actions will hurt your score?

• Missing payments (regardless of dollar amount, it will take 24 months to restore credit after only one late payment)
• Using credit cards at capacity (i.e., maxing out credit cards, measured as utilization rate/amounts owed) 
• Opening up numerous credit accounts in a short time period
• Having more revolving loans (i.e., credit cards) in relation to installment loans (i.e., student loans, car loans)

What does not affect your score?

• Income
• Length of residence
• Length of employment

Approximate weight of each year of credit history, which makes up your credit history portion of your FICO score:

How can you improve your FICO Score?

• Pay down credit card balances
• Do not close credit cards (because total credit amounts & perhaps history length will decrease)
  • Note: If you struggle with appropriate credit card usage and find yourself getting into a cycle of credit card debt or see your debt ballooning, closing your credit cards may be a good option
• Continue to make payments on time (late payments will become less significant over time)
• Slow down on getting new loans
• Acquire a solid credit history with years of experience
• Move from revolving debt (e.g., credit cards) to installment debt (e.g., car loans, mortgages for houses)

As a student, you might think it is too early to think about your FICO score. However, remember that your credit history will decide the score for you in the future when you may be ready to buy a car or a house. Besides protecting your financial reputation as a great citizen and consumer, a high FICO score can help you get better terms and interest rates when you apply for a loan or mortgage.  Additionally, some rental companies and employers will check applicants' credit scores as part of their approval or hiring processes.

 

Practice

Now, you know how FICO score works. Think about paying it forward and teach a friend or a family member a thing or two about the many benefits of keeping a clean financial history.  

 

Congratulations! You can move on to Chapter 5. What's in a credit report?

To review the full module on Credit Cards, click here.